Question
A foreign exchange trader working for a bank enters a long position in a forward contract to buy two million pounds of sterling at an
A foreign exchange trader working for a bank enters a long position in a forward contract to buy two million pounds of sterling at an exchange rate of 1.2000 in six months. At the same time, another trader on the next desk takes a long position in 32 six-month futures contracts on sterling. The futures price is 1.2000, and a futures contract is on 62,500. The forward and the futures prices both increase to 1.2060 at the end of the day the trades being executed. Both traders claim the same profit, but the banks systems show that the forward trader has made a smaller profit than the futures trader has made. The forward trader immediately picks up the phone to complain to the systems department. If you work in the systems department, the answers to the following questions are the explanations you need to give to the forward trader. (Assume that the interest rate is 5%.)
(a) What are the value of the futures and the value of the forward when the futures price and the forward price both increase by 0.0060?
(b) Why are the two values different?
c) If the forward and futures exchange rates both go down by 0.0060, instead of going up, what will be the profit (or loss) of the two traders in their positions and which traders profit (or loss) is bigger?
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